How Do Mortgages Work?

how do mortgages work

Because most people do not have enough cash for the full purchase price of a home, they obtain a home loan (mortgage) to help pay for it. These loans are based on a few borrowing principles.

The Purchase Price

The price of the home agreed upon by the seller and buyer.

Down Payment

The cash amount you pay toward the purchase price of your home at or before closing. Your home loan (mortgage) is the amount of money you borrow. Together, the down payment plus the loan make up the purchase price of the home you are buying.

Interest Rate

The basic cost of borrowing money expressed as an annualized percentage.

Annual Percentage Rate (APR)

The annual percentage rate is the cost of the credit expressed as a yearly rate. Because all lenders follow the same rules to calculate the APR, it is a good way for you to compare the overall costs among your loan options. The finance charges for your loan will include any points and fees assessed, and will be reflected in the APR for your loan. The APR is intended to disclose the real cost of borrowing by adding all charges that would not be part of the transaction if you paid cash for your home.

Term of the Loan

The length of time you have to repay your loan, typically 15, 25 or 30 years.

The Maturity Date

The date the loan is scheduled to be paid in full.

A point is equal to one percent of the amount of money you borrow. Points are charged at the beginning of the loan and are part of the cost of borrowing money. The loan origination fee is one form of points.

PITI is shorthand for four components of your housing expense: principal, interest, property taxes and hazard insurance.

  1. Principal: The amount of money you borrow.
  2. Interest: The amount you pay the lender for the use of the borrowed funds.
  3. Taxes: Real estate property taxes assessed by different government agencies to pay for school construction, fire department service, etc.

    billed by the city, town or county.

  4. Insurance: Property insurance coverage against theft, fire or other disasters as covered by the insurance company.


Tax borrowers may choose to include monthly installments for their anticipated property taxes with their monthly mortgage payment. Impounds represent a portion of a borrower’s monthly payments held by the lender to pay for property taxes as they become due.

Rate Lock

A rate lock or rate commitment is a lender’s promise to hold a certain interest rate and a certain number of points for you for a specified period of time while your loan application is processed. Rate locks can be 30, 45, 60 days or longer. The loan must close and fund within this period to receive the rate promised.

Second Mortgage

Any loan or line of credit on the home made in a junior position to the first mortgage loan can be referred to as a second mortgage. Various uses for the funds include making home improvements, consolidating debts, sending your child to college, etc.

Your home’s current market value less any outstanding mortgages and lines secured by your home.

Closing procedures transfer ownership from the seller to you. Closing costs include fees you pay for the services of the lender and other costs involved with the sale of the home.

Escrow is the practice of delivering all required money and documents to a neutral third party to hold until you, the seller, and the lender have fulfilled all the conditions of the agreements. The escrow agent prepares documents, pays off existing loans, requests title insurance, and divides tax and insurance payments between you and the seller. (In some states, this is handled by an attorney.)

Pre-Payment Charges

Some mortgage lenders charge pre-payment fees if you pay off your mortgage prior to a specified date. Accepting a pre-payment charge on your loan can sometimes enable you to obtain a lower interest rate. However, you should check with your lender on pre-payment charges. You may want to avoid the pre-payment option if you plan to pay down your mortgage early.


Category: Credit

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